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ACCY342 s1 2014 Tutorial Solutions Chapter 6

6.13 Discuss the contention that the control environment is the most important part of a
system of internal controls because it provides the foundation.

The control environment sets the tone of the entity and influences the control consciousness of
its people. People, through their actions, determine the effectiveness of internal controls. If the
control environment does not encourage ethical behaviour and high quality work, the people
within an organisation could fail to implement controls or override them when performing their
duties. Even the best control system is not 100% effective, and all systems are less effective if
the people working with them do not support the systems.
However, all components of an internal control system are important. Having a strong control
environment will not be sufficient by itself to ensure that an organisation is able to achieve its
objectives.


6.16 Explain the importance of segregation of incompatible duties. What sort of duties
would be segregated within the sales process? Why?

Segregation of incompatible duties is a part of the control activities of an organisation. Control
activities are policies and procedures that help make sure managements directives are carried
out. The concept of segregation of incompatible duties is that no one employee or group of
employees should be in a position both to perpetrate and hide errors or fraud in the normal
course of their duties. If these duties are not segregated, an employee could steal assets (such as
cash or stock) and adjust the records to conceal the theft. If the duties are segregated, the
employee stealing the assets would have to get the cooperation of another employee to adjust the
records to hide the theft.
Therefore, it is very important for the effective operation of a control system that incompatible
duties are split between different employees.
Within the sales process, the person making the sale is not responsible for recording the sale, and
should not be able to process a sales return or other adjustment to a debtors account balance. If
these duties were not segregated, the sales employee could record a sale to a fictitious customer
and take the goods for themselves. To conceal the theft, the employee would later process a sales
return or adjustment to eliminate the balance in the fictitious debtors account.


6.30 Objectives of internal control
Required
(a) Give examples of transactions that would occur at Emerald Spa.
(b) Explain what could go wrong with these transactions if the system of internal
controls could not meet any of the seven generally accepted objectives of internal
controls.
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(a) Transactions would include:
Cash receipts from customers for services
Reimbursement from health insurance companies for counselling and massage services
Credit purchases of supplies, such as oils, hair products
Electronic funds transfers to pay wages
Cheque payments for rent, electricity, furniture purchases, insurances, tax remittances,
advertising
Depreciation for furniture and equipment

(b) Potential problems in transactions if control system does not meet objectives include:
Incorrect pricing used for customer services; services provided but not charged to
customers or recorded in the accounts; duplicate receipts recorded
Not all cash receipts are banked intact in a timely manner
Failure to claim reimbursements from health insurance companies on behalf of clients, or
claims for the wrong services
Ordering wrong supplies or sufficient supplies to meet demand
Failure to keep supplies safely locked away, as required
Failure to record purchase of supplies; payment for supplies not received; incorrect cost
of supplies recorded
Branch manager approves salary payments for hours not worked by staff, at wrong rates,
or for staff that do not work for the business
Failure to control costs such as electricity, through inefficient use of equipment
Equipment and furniture not accounted for, not kept secure at the premises, charging
depreciation on furniture and equipment no longer used by the business; failure to record
depreciation because equipment not recorded as asset
Repairs to furniture and equipment recorded as new purchases of assets; new purchases
recorded as repairs



6.32 Segregation of duties and documentation
Required
(a) Create a flowchart to represent the flow of transactions from the raising of a
purchase order to cash payment.
(b) Which duties in the above process should be segregated?

(a)


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Requisition for stock
prepared by stores sent to
purchases department
Funds
available?
Approved
vendor
available?
No
Refer to purchases
manager to source
approved supplier
Yes
No
Yes
Request
approval to
exceed
purchases
limit
Request
approved?
No
Reject
purchase
requisition
Yes
Create purchase order and
send to vendor
Receiving report, packing list
and supplier invoice
received
Do quantities, unit price
and shipping agree to
purchase order?
No
Yes
Contact supplier to
resolve discrepancy
Stock receival
process
Supplier payment
process
Process purchase in
purchase ledger
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(b) As indicated on the flowchart, the stores which create the requisition and receive the goods
are separate from the purchasing process. The stores manager is not permitted to make
purchases directly with suppliers because there needs to be a segregation of the authority to
commit the entity to purchasing goods and the custody of the goods. The recording of purchases
into the stock account is separated from the record keeping at the stores.
Also, the payment process is separate from the purchases process. At various points in the
process, permission is sought from purchases manager and the accountant for action. The
purchases manager arranges for suppliers to be selected and approved. Only approved suppliers
are used to ensure that they are reliable and the items meet the entitys specifications. The
accountant gives permission to create purchase orders if the purchases department does not have
approved funds available.
Payment is not approved for processing until the purchase order, receiving report and packing
list, and supplier invoice are matched and reconciled. Not shown on this flowchart, approval for
processing the payment would be required before the supplier is paid.



6.35 Components of internal control
Required
Select two (2) components of internal control. Explain how the role of internal and
external audit would differ in assessing these components in relation to the new
manufacturing costing system.


(1) Control Environment.
The high level of security around information relating to product design, manufacturing and
costing, and the client identity and transactions is a key part of the internal control system at
Securimax. The secure environment provides the foundation for the successful implementation
of the new manufacturing costing system because data are secure and only certain personnel will
have access to it.
The highly secure environment indicates that the control environment at Securimax has a focus
on clear assignment of authority and responsibility and a formalised organisational structure. It
also reflects managements philosophy and operating style which rates security highly.
Consistent with this approach it would be expected that internal audit have a formal and
important role in the organisation. Internal audit were involved in all stages of the installation of
the new manufacturing costing system. Their role would have been to ensure that the integration
with other systems (e.g. sales) is correct. Internal audit will also be interested in maintaining the
secure environment and assessing the performance (i.e. efficiency and effectiveness) of the new
system.
External audit would focus on understanding the control environment and assessing whether the
control environment means that management has positive attitudes towards internal control
systems. The auditors would be interested in assessing how well the implementation of the new
costing system was executed, and whether the secure environment was maintained.



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(2) Risk assessment process.
The risk assessment process refers to managements processes to identifying and responding to
business risks. Securimax has responded to the risk of using inaccurate costing data by installing
the new manufacturing costing system. However, there are risks involved with the installation
and these would need to be managed.
The internal audit department would be involved in assessing how management handle the
implementation and other risks.
The external audit department would use the information from the internal audit departments
assessment to evaluate the level of risk to the financial accounts from any problems with the
manufacturing costing system.

(3) Control activities
The information provided does not explain the segregation of duties and physical controls
relating to the new manufacturing costing system. However, internal audit would assess the level
of segregation and physical controls when determining the success of the implementation
process.
External audit would require an understanding of these matters in order to assess control risk for
transactions relating to the costing system.